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Can Obama Keep New Jobs at Home?

Massive fiscal stimulus could wind up creating jobs offshore as funds are spent on imports

President-elect Barack Obama has made a promise: to save or create 2.5 million jobs over the next two years. Estimates of the cost of his high-powered spending program to rescue the U.S. economy start at $500 billion and go way up from there.

But a giant issue lurks: How much of Obama's mammoth fiscal stimulus will "leak" abroad, creating jobs in China, Germany, or Mexico rather than the U.S? This is a question with big economic and political implications—and no easy answers.

One problem is that over the past 25 years the U.S. has become the "consumer of last resort" for the world economy. Imports have risen from the equivalent of 9% of gross domestic product to almost 19%. Even more astonishing, the value of imported goods now is equal to almost 40% of the output of U.S. manufacturing. For some types of consumer goods, such as clothing and consumer electronics, it's increasingly difficult to find items that were not made abroad. As a result, fiscal stimulus that boosts consumer spending in the U.S. may be diffused through the global economy, reducing its impact on jobs here.

At the same time, Obama will face intense political pressure to make sure his intended spending on infrastructure, health-care modernization, and green technology creates manufacturing and service jobs in the U.S. Federal procurement is already governed by a complicated welter of laws mandating minimum "domestic content" for many types of federal purchases, including the Depression-era Buy American Act. That's why, for example, steel for federally funded transit projects typically has to be made in the U.S.

No Sideshow

The scale of the fiscal stimulus will likely ensure a frenzy of lobbying to tweak the existing domestic content rules and add new ones. But the more rules and earmarks that are built into the package to ensure domestic jobs, the more expensive it will get and the more the U.S. will look as if it's retreating from free-trade policies. "Job leakage will continue," says Susan Houseman, a senior economist at the W.E. Upjohn Institute. "For better or worse, Obama and Congress will be under tremendous pressure to plug that leak."

The coming debate over "Buy American" restrictions in the fiscal stimulus is no sideshow. The financial crisis was caused, in large part, by U.S. consumers borrowing trillions of dollars from the rest of the world to buy imported cars, clothes, and gasoline, even as jobs slipped overseas. As long as the U.S. is running a big trade deficit and borrowing from abroad, a fundamental cause of the crisis remains.

Now, whether Obama's stimulus package creates 2.5 million jobs or not, economists believe it is a good idea, given the ferociousness of the downturn. "Without it, you could get a protracted period of negative or weak growth," says Nariman Behravesh, chief economist of IHS Global Insight in Lexington, Mass. "With it, you could get the economy coming out of recession in the third quarter" of 2009.

Vanishing Factories

Yet given the U.S. appetite for imports, hitting the Obama jobs target will be tough. When President Ronald Reagan cut taxes during the deep recession year of 1982, the U.S. was still a relatively closed economy. That meant when consumers started spending, the jobs showed up in this country.

Over the past 10 years, however, the number of manufacturing jobs in the U.S. has plummeted, going from 17 million in 1997 to 13 million today. The part of the Obama plan that props up consumer spending will not bring back those lost factory jobs.

In fact, Obama does aim to get money into the hands of consumers, through extended unemployment benefits and aid to state and local governments that might otherwise lay off workers or raise taxes. J. Fred Giertz, a state budget expert at the University of Illinois at Urbana-Champaign, notes that in 2003, $20 billion of federal assistance was allocated to states, with about half earmarked for Medicaid. How much this time? "Something in the range of 5% to 10% of the stimulus package would be a good guess," says Giertz.

The advantage of these types of spending is that they are fast-acting. The disadvantage: They support the same "U.S. as consumer" mentality that got us into trouble in the first place, along with purchases of imports.

What about spending on infrastructure, health-care modernization, and green technology? All these tend to produce less leakage overseas than consumer spending. But even jobs in these areas have a tendency to slip over the border unless carefully constrained. Spending on infrastructure such as rail transit is more likely to create domestic jobs, in part because it is already covered by federal legislation that mandates a certain level of purchases of U.S.-made goods.

For example, new public transit vehicles generally must have 60% domestic content and be assembled in the U.S. Electric streetcars—a mass transit option to cut pollution that's favored by cities such as Denver and Salt Lake City—would likely be imported from other countries if it weren't for the "Buy American" requirements attached to federal funding.

Furious Lobbying

Such restrictions are not new. The original Buy American Act, still in effect, was signed by President Herbert Hoover on his last day in office in 1933, requiring the federal government to prefer U.S.-made goods. Over the years the law has been riddled with additional exemptions and waivers and partially superseded by other laws governing trade.

The existing legislation means much of the spending in the fiscal stimulus package—including for green infrastructure—will be subject to intense lobbying to ensure that the money creates jobs in the U.S. and not overseas. Paying someone to better insulate a home will clearly create a domestic job. But how much of the insulation will come from China, a major producer? Or what levels of domestic content will solar panels have to include?

Many of the biggest solar and wind power companies wouldn't be affected by domestic content rules, because they are already setting up operations in the U.S. for business reasons, says Michael McNamara, an analyst at Jefferies International (JEF) in London. For example, very large components such as wind turbine blades are expensive to transport long distances. Adds Ralph Wiechers, chief economist of the German Engineering Federation, the association for the machinery industry: "The Democrats know how important world trade is."

A lot depends on how the rules are written. German-owned factories in the U.S. "are often dependent on suppliers from Germany," says Wiechers. "Then it's a question of the definition. Is a machine made in the U.S. if 50% or 60% of the value is created in the U.S.? That wouldn't be a problem."

Another possibility is to take a long-term approach and opt for more spending on education, research, and health care. These are all areas that create domestic jobs and are crucial for future competitiveness and innovation—but take a lot longer to ramp up.

Hiring teachers could have a double benefit, creating jobs while boosting the productivity of future workers. "The rate of return to early childhood education is around 10%—a very, very healthy investment," says James J. Heckman, a Nobel prize-winning economist at the University of Chicago "Leaf raking, job corps, and sports stadiums lack such a return." Similarly, Clair Brown, an economist at University of California at Berkeley, is arguing for increasing basic research funding from the government to U.S. universities, which would create jobs in this country. "The competitiveness payoff will be with us for years to come," says Brown.

Obama's political task will be easier if other countries spend big to jump-start their economies as well. Then a rise in export-related jobs in the U.S. could make up for any jobs that leak out. Indeed, this is the best course for the global economy, with each nation supporting the others. "All of these countries affected by collapses in asset prices and facing a very severe recession have to put in fiscal stimulus," says Richard C. Koo, chief economist at the Nomura Research Institute in Tokyo. "And it has to be a global effort and not just an American effort. We all have to do it."

The announcement by Britain on Nov. 25 of a $30 billion fiscal stimulus package is a start. But, writes George Magnus, senior economic adviser for UBS Investment Bank (UBS), "so far the European initiatives have been disappointing and halfhearted." Wiechers of the German Engineering Federation is critical of the German government's reaction so far. "Every day there's a new proposal on the table. If they're going to do something, they should do it fast."

Back in the U.S., Obama faces an enormous challenge. He needs to push through smart, targeted investments that create real jobs, avert a potential deflationary spiral and economic depression, and renew the American economy for another run of long-term prosperity. It's going to take all of Obama's political smarts—and plenty of luck—to navigate successfully through this crisis.

The global slump has rekindled a long-running debate over whether changes in government spending and taxes can help smooth out business cycle fluctuations. In the October 2008 edition of the IMF's World Economic Outlook, the fund's economists point to empirical evidence suggesting that discretionary fiscal policy can have a moderately positive effect on output growth in advanced economies.

To read their report, go to http://bx.businessweek.com/bailout/reference/.